In financial markets participants buy and sell debt securities, usually in the form of bonds. The Securities Industry and Financial Markets Association (SIFMA), classifies the bond market into sub-markets, including asset backed securities (ABS), which includes mortgage backed securities (MBS), residential mortgage backed securities (RMBS), commercial mortgage backed securities (CMBS), other ABS which includes securities backed by student loans, automobile loans and credit card loans and collateralized debt obligation (CDO) securities. The present invention is concerned primarily with the ABS market.
For decades a succession of legislative and regulatory enactments, as well as market-driven initiatives, have provided the fuel for rapid growth of the housing market in the U.S., which has transformed from a fragmented and inefficient system to a liquid and vibrant market. The result is a housing market that has grown markedly from a liquidity-starved system to one in which liquidity is abundant. Initiatives undertaken by numerous market participants include actions to standardize the origination and securitization of home mortgages. The evolution of primary and secondary mortgage markets has made mortgage credit widely available and at lower costs to borrowers. In addition, funding efficiencies have benefited issuers and increased choices have benefited investors in fixed-income products. Also, over the last several decades consumer credit has become increasingly available. The growth of financial liquidity has led to evolvement of a wide variety of structured products to promote and facilitate the extension and use of credit, home ownership, and the profits that go along with providing such financing. However, the result of over-extension of credit, predatory lending, moral hazards in the system, and associated defaults has caused the U.S. government, regulatory agencies, and the financial industry to revisit, rethink and re-engineer credit and lending policies and structures to avoid further damage to the market and economy.
The following provides a background of the processes associated with the ABS securities market. Generally, securitization refers to a structured finance process in which cash-flow producing financial assets are pooled and repackaged as a portfolio into securities that are sold to investors. ABSs are a debt-based security based on pools of assets or collateralized by cash-flows from an asset pool. Because the credit quality or rating of securitized assets associated with cash-flow is ever changing due to time and structure-dependent volatility, this type of security has an inherent risk to the structure. Advantages of pooling assets in this manner include making investing in such types of debt worthwhile and to a broader range of investors, and reducing the risk of such investment by diversifying the underlying pooled assets. Pooled assets can include receivables related cash-flows, such as credit card payments, student loans, auto loans, and mortgages, aircraft leases, royalty payments and movie revenues. An additional benefit to this type of security is credit enhancement that results from creating a security with a higher rating than the issuing company which monetizes its assets resulting in a lower rate of interest than associated with a secured bank loan or debt issuance.
Mortgage-backed securities (MBS), including residential MBS (RMBS), are ABSs backed by a pool of mortgage loans and collateralized with principal and interest payment cash-flow. Typical residential mortgages allow for payment over and above the fixed monthly payment, including even the complete retirement of the remaining debt. This advancement or prepayment has the effect of altering the principal on the loan and on the monthly cash flow of an MBS and is a variable over time that presents a risk to the structure of the MBS and to its investors.
Collateralized debt obligations (CDOs) are a type of ABS and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. CDOs are divided by the issuer into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. Since 1987, CDOs have become an important funding vehicle for fixed-income assets.
The recent credit crunch has confirmed that the widespread reliance on ABSs pose great risk to financial markets due to a fundamental flaw that causes all tranches to be extremely high risk for investors. One of the problems with ABSs in general is that loan originators retain no residual risk associated with the loans they make, and that make up the pool of assets in ABSs, but collect substantial fees in issuing the loans. This imbalance in risk/reward has resulted in the degradation of underwriting standards as the risk is passed down the line. This fundamental structural flaw in the debt-securitization market is one of the direct causes of both the credit “bubble”, credit crisis, and banking crisis of this decade. Adding to the problem was the failure of credit rating agencies to account for the degradation in underwriting standards when evaluating the structure and value of ABS products, as well as not modeling for the severe downturn in the housing market which makes up the collateral for the RMBS market, which saw the highest level of subprime and Alt-a mortgage securitization in history by both volume and percentage of the overall markets. Like a row of dominoes falling, investors buying ABSs, unable to independently gauge ABS structure and performance, relied on these exaggerated ratings. The collapse of the financial market has caused investors to lose confidence in the integrity of ratings agencies, and the ratings they assign. These recent, well documented problems in the credit markets have revealed the need for better transparency and information in the Structured Finance arena. A clear need exists for access to more and better information and for using that information to add integrity to the ratings process to enhance investor confidence in the credit markets.
One organization that is involved in exploring ways to address the current market needs is The American Securitization Forum (“ASF”), a subsidiary of SIFMA. ASF recently announced the launch of its Project on Residential Securitization Transparency and Reporting (“RESTART”) with the stated goal of restoring investor confidence in mortgage and asset-backed securities. ASF believes this will restore institutional investor capital to securitization markets and ultimately will increase the supply and lower the cost of mortgage and consumer credit. To this end, ASF has identified areas of improvement in the process of securitization and refashion, in a comprehensive and integrated format, the critical aspects of securitization with market-based solutions and expectations. RESTART has been divided into phases that are sequenced for release and implementation through 2009. The initial focus of RESTART is on the private-label residential mortgage-backed securities (“RMBS”) market with similar efforts to be pursued in other major asset classes such as student loan, credit card and automobile securitizations. ASF published a document detailing RESTART, entitled ASF Project RESTART, at its website (http://www.americansecuritization.com/uploadedFiles/Project_RESTART_RFC_%207—16_%2008.pdf). This document is referred to hereinbelow and is hereby incorporated by reference.
The first major component of RESTART released was the RMBS Disclosure Package. ASF stated that key goals of the effort are transparency, disclosure and diligence. The RMBS Disclosure Package included in the RESTART release document reflects the focus on developing specific and detailed market standards and practices that, through market-imposed incentives and discipline, will result in their implementation by all applicable industry participants.
According to ASF, an important factor in the success of the residential mortgage-backed securities markets has been the standardization of terms and the transparency of information available to parties taking, assessing or distributing risk. Capital commitment decisions by loan originators, financial intermediaries and fixed-income investors, as well as risk assessments by rating agencies, should be made with as much consistent disclosure as is cost-effective. Moreover, it is also critically important that this information be comparable across issuers and servicers without unnecessary and inefficient ‘normalization’ by transaction parties, particularly institutional investors. Limitations on lender's balance sheets and capital constraints make the need to restart the mortgage securitization markets great. However, successful restoration of the credit market will require providing institutional investors, who are mostly at risk credit risk of mortgage loan defaults, with more information about and more confidence in the origination process and in the ongoing soundness of a securities structure.
Project RESTART included the development of standardized data fields that would add to the transparency and disclosure of information to market participants. Two aspects proposed in the initial phases of the Project RESTART include: ASF RMBS Disclosure Package and ASF RMBS Reporting Package. RMBS Disclosure Package is a proposed disclosure package to (1) provide more data than currently available to institutional investors, rating agencies and other eligible RMBS market participants about the underlying mortgage loans, (2) standardize the presentation of deal and loan-level data to allow investors to easily compare loans and transactions across all issuers and (3) allow investors to perform necessary and sufficient deal and loan-level analysis in order to evaluate RMBS transactions on the basis of the credit quality of the underlying mortgage loans. RMBS Reporting Package is a dynamic set of data elements derived from the RMBS Disclosure Package that can be updated by servicers on a monthly basis throughout the life of an RMBS transaction and made available to investors and rating agencies through trustee or servicer investor reporting websites and other third party information providers. The RMBS Reporting Package will allow investors and rating agencies to compare updated data files across issuers and to track the performance of a mortgage loan throughout its life in the secondary market.